Wrong-way Corrigans?

ANNANDALE, Va. (MarketWatch) - Contrarians always are on the lookout for a new group of investors that are reliably wrong.

Many such groups are already on contrarians' radar screens, of course -- everyone from newsletter editors to options traders to mutual fund managers.

But until Wednesday I had not come across the suggestion that foreign investors might be another group on which contrarians' could profitably focus.

So I sat up and took notice upon reading commentary from a firm called ActionEconomics.com about foreign investors in the U.S. stock market. "Historically, foreigners tend to be a good fade indicator," the firm wrote, "significantly increasing buying near market tops and drastically cutting back demand near market bottoms."

ActionEconomics.com's commentary was stimulated by the U.S. Treasury Department's report Wednesday of a big jump in foreign net purchases of U.S. stocks in the latest month. Foreigners purchased $24.6 billion more U.S. stocks during September than they sold, the most since February 2000.

Any similarity to February 2000 is worrisome, of course, since it came just before the beginning of the 2000-2002 bear market. "It will be interesting to see what develops in the months ahead," ActionEconomics.com wrote.

This commentary sent me scurrying to see what statistical support there might be for this contrarian use of foreign investors. After obtaining Treasury Department data on foreign net purchases of U.S. stocks back to 1978, I tested for any correlations that might exist between a given month's reading and the stock market's subsequent performance.

Unfortunately, try as I might to find a statistically significant correlation, I found very little.

Part of the difficulty is that the Treasury Department doesn't release the data for a given month's net foreign purchases until six or seven weeks after the close of that month. So, to the extent the data can actually be used by contrarian, it is in forecasting market movements lasting more than just a month or two.

Yet foreign investors, just like U.S. investors, tend to be a rather fickle lot from month to month, sometimes pouring money into U.S. stocks in one month and pulling out the next. As a result, one month's data might lead us to make a bullish forecast for the next several months, while the next month's data would lead to just the opposite forecast.

Consider, for example, the $13 billion of net purchases that took place in December 2003. Prior to this past September, that month's reading was one of the largest in recent years. From a contrarian point of view, that supposedly should have meant that the stock market would decline for much or all of 2004.

Yet in March 2004, just three months later, net foreign sales of U.S. stocks amounted to nearly $10 billion. Only two other months over the last 27 years have experienced more net sales than this. That should have been bullish.

John Dessauer is not surprised by the absence of a strong statistical case for a contrarian view of foreign investors. For several years during the mid 1970s Dessauer was Senior Investment Officer for Citibank in Switzerland, and for the past two decades he has been editor of an investment newsletter in the U.S. called John Dessauer's Investors World. So he is uniquely able to compare foreign investors with those in the U.S.

In an interview Wednesday afternoon, Dessauer said that "there is no reason to expect foreign investors to be any better or worse at timing the stock market than U.S. investors. They move in and out of U.S. stocks more or less just like the rest of us."

The bottom line? The stock market very well may decline over the next several months. But if it does so, it most likely will not be because foreigners in September were such big purchases of U.S. stocks.

The most recent edition of the Hulbert Financial Digest is available by e-mail or regular mail. Highlights include:

-- If you think the stock market has gone nowhere since 1999, think again.

Intraday Data provided by SIX Financial Information and subject to terms of use.
Historical and current end-of-day data provided by SIX Financial Information.
All quotes are in local exchange time. Real-time last sale data for U.S. stock quotes reflect trades reported through Nasdaq only.
Intraday data delayed at least 15 minutes or per exchange requirements.